Bond

Yesterday was one of the strangest days in awhile - and that is from a long list of strange days. The most confusing part is that over the weekend Dexia went through some form of nationalization - the details of which and the need for which remain sketchy. Erste decided to take some big write-downs on CDS positions it had written, and Merkel and Sarkozy yet again held a joint press conference to announce that now they were really serious about saving everything and everyone. European stocks and credit had a relatively muted reaction. Stocks were up small. The Dax for example was drifting from slightly down to up less than 1%. SOVX was a touch wider and MAIN was a few bps tighter. Then the US came along and told Europe that they didn't realize how good they had. Yes, US equity players came along and told Europeans they didn't understand what had happened in their own backyard. The US stock market dragged Europe higher and tighter with it. Investors who were short IG17 or HY17 were hitting bids in MAIN, XOVER, and buying JNK, LQD, and HYG, along with SPX. Today, Europe was basically treading water and tried to do better at 7am as the US opened for business. Since then we have started to drift wider and lower. Part of this is going to be funds getting their positions squared away as they can now sell some IG17 and buy back their other hedges. Credit traders who are left scratching their heads about how things were "fixed" over the weekend are back and fading this rally.

A week ago our post announcing that the Greek deficit target was going to be revised higher once again, from 7.6% to 8.5%, started with the following sentence: "As the Greek parliament meets to finalize huge public sector job cuts, Reuters is reporting that Greece will miss the deficit targets set in its EU/IMF bailout this year and next... We would say "again" but at this point "as usual" makes far more sense." Guess what: it is time to "as usual" re-re-revise it once again.

Michael Lewis’ latest piece in Vanity Fair, “California and Bust,” begins with a lengthy defense of Meredith Whitney’s prediction that there would be a wave of defaults in the municipal bond market. I was not planning on writing a response to his article – frankly, defending Whitney’s call at this point is very much like defending Harold Camping’s prophesy on May 22^nd, after even the most gullible people have realized that they euthanized their pets for nothing. Who really cares about the intransigent believers that remain, for whom a forceful narrative has always been more relevant than facts?

Today, all is good in Europe... Except for the festering wound at the center of the contagion of course. It appears someone forgot to tell Greece all is well - it must be that Columbus day holiday or something.

We would point out that USD Libor is wider again this morning but at this point it is irrelevant: for a multi-billion core European bank to go insolvent "overnight" (nobody could have foreseen it and all that), and with Libor to still be trading under 1%, and specifically, under the USD FX swap line penalty rate, it means that the BBA market is either completely broken or criminally corrupt and colluded. Take your pick. So instead we will focus on what actually does matter in the market, such as the fact that ever more banks are exhibiting the fear and loathing discussed earlier this weekend, with an unprecedented scramble to dump every last eurocent in the "safety" of the ECB's clutches: as of Friday, a whopping €255.6 billion ($345 billion) in cash stood idle, and hence as far away as possibl;e from normal interbank liquidity, parked with the ECB: the highest since June 30, 2010. Expect this number to jump even more tomorrow when the Monday, aka "post-Dexia" number is released. And elsewhere, as expected, Belgium sovereign bonds are already starting to take on ever more water, as Belgium and France 10 year notes fall and the French 10 yield hits highest in over a month. Belgium and France govt bonds will be pressured as fallout from Dexia highlights risks and costs to state from banks’ exposure to peripheral debt, Padhraic Garvey, strategist at ING, writes in note. Specifically, the Belgium 10 Year yield is at +7bps to 4.05% while the 2-yr yield +4bps to 2.34%. At least the curve is not massively inverting just yet. In France, the 10 Year yield is +7bps to 2.83%, the highest since Sept. 2. The spread widening in these two countries will not stop as an imminent rating agency downgrade overhang is now a threat to bondholders of both countries. Said otherwise, the Dexia-Belgium CDS compression trade is alive and profitable.

In a first for the Fed, 15 minutes ago the Fed started its first anti-POMO, or outright bond sale, this time for up to $9 billion in bonds due between 01/15/2012 – 07/31/2012. This is liquidity taken out of the market (think reverse repo) and money that can not be used to buy Netflix by the primary dealers. As a result, the recent (massively levered: thank you HFT in FX and 200x margin) surge in the EURUSD would make sense, as the last thing the market needs is for the robots to find a correlation between inverse POMO days and market drops, which would then be front run on any of the next anti-POMO days. The operation will conclude at 11 am EDT. Expect to see an end to the EURUSD rise as soon as the operation is concluded.

The Associated Press is reporting on an very appropriate comment from Antonio Borges, head of the IMF's Europe program, that he is retracting his earlier comment that they will intervene in bond markets to support Italy and Spain. Sure enough, this will not come as a surprise to our readers, after we said first thing today that "we find that the person tasked with destroying his credibility, after the market no longer trusts anything Lagarde says, is IMF European Department Director Antonio Borges who according to Reuters, said that Europe needs between 100 billion and 200 billion euros to recapitalize its banks to win back investor confidence and should carry out the plan across the continent, not in a staggered process." Consider credibility destroyed. Oh to have been a fly on the phone call from Christine Lagarde to Borges in which she, in a calm, cool, and collected manner, with little to no use of obscenities, and references to the Spaniard's mother, grandmother, and barn animals, explained to him to, very credibly say he was only kidding.

We’ve updated our chart of the sources of financing of the U.S. budget deficit from the Fed’s Flow of Funds data released on September 16th.   The chart illustrates how the Fed and foreign central banks have been indirectly fully funding the  massive U.S. budget deficit for the last three quarters.   It will be interesting to see the data for the quarter ending today as no doubt there will be less yellow with the end of Q2 on June 30 and more “flight to quality” blue (domestic) and red (rest of world).

Anyone who thought that yesterday's atrocious 5 Year E5 Billion bobl auction was a one off fluke may need to reevaluate after today's even uglier Italian bond auction which was not a failure in all but name, after the Italian Treasury raised far less than was targetted. As a result, Italian bonds have slumped, extending losses from earlier this morning. That said, we expect a near-term kneejerk reaction once the German EFSF vote ratifies as is broadly expected. Specifically, per Bloomberg, the 10-yr yield hit 5.69% after auction from 5.66% pre-auction; now steady at 5.66%, +2bps from yesterday, it also sold EU1.3bln vs targeted EU2bln on bonds due August 2021; Italy sells EU2.47bln vs targeted EU2.5bln bonds due March 2022 with avg yield of 5.86% vs prev 5.22%; 2-yr yield +3bps to 4.4% vs 4.37% pre-auction. The govt sold EU3.14bln due July 2014, less than the targeted EU3.5bln bonds; avg yield of 4.68% vs prev 3.87%; 5-yr yield +6bps to 5.08% vs 5.07% pre-auction Italy sold EU926m vs targeted EU1bln bonds due December 2015.

In a brief note this morning from Goldman, the correlation between European equities and bond yields is noted at a 40-year high - above the levels reached in the initial credit crunch period of '07/'08. They find that the rolling correlation is highly dependent on the absolute level of bond yields and at current levels is very indicative of significant growth concerns (much more so than any inflation fears) and furthermore that the relationship is starting to look a lot like the lost twin-decades in Japan.

A completely and thoroughly bankrupt Greece has just crossed some imaginary rubicon where it no longer deems it fit to even lie, and instead will simply not report any data. As Bloomberg reports, Greek FM Evangelos Venizelos, never to be confused with Jenny Craig, spoke to reporters in Athens today and told them that while the figures for the bond swap are optimistic, they are strictly confidential and will not be released by the Greek government. Considering that bond tender offer tabulation takes about 24-72 hours in even the most complicated of bankruptcies, this is a tacit admission that Greece has been unable to even complete the simplest of Greek Bailout 2 prerequisites, which is to get its bondholders to agree to an implicit 21% haircut, which is precisely as Zero Hedge predicted when we observed that German banks have sold their bonds to hedge funds which in turn are now holding Greece hostage in exchange for nuisance value. An irrelevant Venizelos also added that the target is to have all new measures passed October end, that austerity measures votes will be separate from a budget vote, and that Germany is to provide all help to stabilize Greece. We are sure the last will be news to tens of millions of German citizens.

Back on July 21, the same day as the Greek bailout redux hit the tape, we speculated that the biggest weakness in the Second Greek Bailout is that the EFSF would have to be expanded to well over the current E440 billion (which even at its current size has not been fully ratified in Europe, and based on recent events may not be implemented until 2012 thanks to Slovenia and Finland), or about E1.5 trillion (and possibly as much as E3.5 trillion). The reason this is a "problem" is that it would have to come exclusively at the expense of Germany which would have to pledge anywhere between 50% and 133% of its GDP (as France would have long since been downgraded and hence unable to participate in the EFSF at a AAA rating). We also assumed that the debt rollover with a 21% haircut would not be an issue as it should have been a formality: on this we were fataly wrong - the debt rollover plan has imploded and means that the entire Greek bailout has collapsed as some had expected. And now that it is clear that contagion is threatening to sweep through the core, it is back to Germany to prevent the gangrene, no longer contagion, from advancing beyond the PIIGS. However, in order to prevent a full out revolution, Germany's economic elite has said it would agree to an EFSF expansion and hence installation of European firewall, but at a price: a "controlled" default by Greece and 50% haircuts for private bondholders (as German banks have long since offloaded their Greek bonds).

30Y rates move more than three standard deviations this week - the greatest move since Black Monday (1987) - as it drops 55bps - hhmm - stability.

Import prices and the budget balance; On the funding side, Treasury will auction off 4 week bills and 10 Year bonds to pay for all this fun and games. Luckily nobody ever expects to be repaid pre-hyperinflation.

Despite another round of unsubstantiated rumormongering by the FT yesterday (more on this in a second), investors in this morning's critical round of Italian bond issuance were nonplussed and demanded 10 pounds of flash with every bond, which in turn sent 5 year BTP yields to the highest since the introduction of the zEURo. If the purpose of the planted Debtwire/FT story was to make this auction attractive, one can only conclude that it failed. The result is yet another"Europe is Open" type market session, where everything is tumbling on Greek default and contagion fear, further stoked by a front-page WSJ story which says what we have been warning about every single day for the past 3 weeks (those pretty Libor charts that go from the lower left to the upper right are not just there to make the place pretty): namely that banks, in this case French mega institution BNP, no longer have access to dollar funding markets. The result: yet another increase in the actual 3M USD Libor rate, nearly the 40th day in a row, which in turn makes the dollar lock out even more painful. From the WSJ: ""We can no longer borrow dollars. U.S. money-market funds are not lending to us anymore," a bank executive for BNP Paribas, who declines to be named, told me last week. "Since we don't have access to dollars anymore, we're creating a market in euros. This is a first. . . . we hope it will work, otherwise the downward spiral will be hell. We will no longer be trusted at all and no one will lend to us anymore. He's not the only one worried. Société Générale has lost 22.5% of its value since the beginning of the summer. In early September, BNP released a statement—in English, which is highly unusual—explaining that it has abundant dollar liquidity and that BNP has nothing to worry about, unlike other banks. France's three biggest banks have been the subject of whisper campaigns about their solvency throughout the summer." It gets worse: "Now that the situation is bordering on catastrophe, analysts are suggesting that the government is set to start nationalizing France's banks. The banks have remained silent on the matter, and the government denies this talk." Well, whatever good will the FT tried to create with its rumors,the WSJ destroyed with its facts.